Introduction
At the close of June 2022, the S&P 500 had drawn
down more than 20% from its most recent all-time
high, set on the first trading day of January 2022.
This marked the 11th time since 1950 that the
benchmark stock market index drew down by at
least 20% from an all-time high. In total, the index
has declined by 10% or more from its recent high 21
times since 1950.
Much of the blame for 2022’s bear market has been
placed on factors including supply chain shortages,
US inflation surpassing 40-year highs, and
unprecedented rate hikes as the Federal Reserve
attempts to tame rising prices.
While major market declines are nearly impossible
to predict, that hasn’t stopped market pundits
and doomsday planners from doing so. But
dramatics aside, is there any fool-proof, or at least
somewhat reliable, way to stay ahead of stock
2
market declines? Similarly, can advisors develop
any actionable plan to communicate what might be
around the corner to their clients?
Certain market valuation indicators have been used
to gauge whether there is an increased risk of a
market crash. Ranging from market-wide price-
to-earnings ratios to GDP measurements named
after legendary investor Warren Buffett, investors
and advisors alike have used a suite of valuation
indicators to assess whether the market is about to
tumble downhill, and take their portfolios with it.
To shine light on which valuation metrics are
effective at foretelling market declines—if
any—we analyzed seven of the most commonly
used indicators and measured their accuracy in
predicting 21 major market declines (as measured
by the S&P 500) since 1950.
Summary Table of Key Findings:

5
 Major Decline
a decline of 10% or greater
from the S&P 500’s most
recent all-time high

Peak Date
date of the S&P 500’s newly
set all-time high

Trough Date
date of the S&P 500’s relative
low point following its latest
all-time high

Trough Max Drawdown

the S&P 500’s max percent
drawdown, from Peak Date
through Trough Date close

* As of 6/30/2022, a new S&P 500 all-time high was yet to be set.

7
S&P 500
CAPE Ratio
What is it?

The S&P 500 Shiller Cyclically Adjusted

Price-Earnings (CAPE) Ratio is defined as
the ratio between the S&P 500’s current
price divided by the 10-year moving
average of inflation-adjusted earnings.
The metric was invented by American
economist Robert Shiller and has become
a popular way to understand long-term
stock market valuations. Much like the
S&P 500 P/E Ratio, a higher S&P 500
CAPE ratio means the S&P 500’s index
level is outpacing the 10-year moving
average of inflation-adjusted earnings
from its constituents.
Tobin’s Q
What is it?

Tobin’s Q measures the market value of one

or all public companies in the US, divided
by total replacement cost. A Tobin’s Q level
above 1 would mean a company’s stock is
more expensive than the replacement cost
of its physical assets, implying that the stock
is overvalued. At the total market level, many
macroeconomists consider the market to be
overvalued when Tobin’s Q is above its long-
term mean and undervalued when below
the long-term mean.
Negative S&P 500
YoY Earnings Growth
What is it?

S&P 500 Year-Over-Year (YoY) Earnings

Growth is the change in aggregate S&P
500 earnings from one calendar year ago.
Negative S&P 500 YoY Earnings Growth
signals a reduction in corporate earnings
from the same quarter of the year prior,
and declining earnings can jeopardize
advances from the S&P 500, like they
have done before.
Negative
Yield Spreads
What are they?

A yield spread is the difference between yields

on two fixed income instruments of different
durations. In the world of treasury spreads, a
negative yield spread occurs when the rate on
the longer-term treasury is less than that of the
shorter-term product. Yield spreads that turn
negative signify a flattening or inverted yield
curve, and are commonly viewed as warnings of
a recession and their (typically) accompanying
market declines.

Because of their consistent track records of

signaling recessions, two of the most closely
followed spreads are the 10 Year-3 Month Yield
Spread and the 10-2 Year Yield Spread.
The
“Buffett Indicator”
US Total Stock Market Capitalization
as a Percentage of GDP

What is it?

This indicator measures the ratio of all US

stocks’ combined market capitalization to
US Gross Domestic Product (GDP). Known
as the “Buffett Indicator”, for Warren
Buffett once called it “the best single
measure of where valuations stand at
any given moment”, a ratio of 1:1 or 100%
deems the market fairly valued. When
US Total Market Capitalization surpasses
GDP, the indicator points to overvaluation
for stocks.
S&P 500 P/E Ratio
What is it?

The S&P 500 Price to Earnings Ratio

(P/E Ratio) measures the amount paid in
US Dollars for $1 of earnings-per-share
(EPS). The price to earnings ratio is a
valuation metric that gives investors a
general idea of how a company’s stock is
priced compared to all others, but most
importantly their industry or sector peers.
Aggregated at the market level, a higher
S&P 500 P/E ratio signals the S&P 500’s
index level is outpacing the earnings-per-
share growth of its constituents.